Bring balance back to the economy

As the slide in oil prices impacts the economy and the repercussions for planned investment and employment become clearer, it’s an opportunity to reflect on Canada’s out-of-balance economic growth.

Manufacturing has been put through the wringer during the last 15 years. An over-valued dollar, intense competition in US and global markets, and the 2008-09 recession took a heavy toll on businesses and workers. Fifteen years ago, manufacturing accounted for almost 16% of Canada’s GDP, but it represents less than 11% today. Employment in the sector fell by more than 25% from its 2002 high, and today remains at the low levels reached when the economy bottomed out in 2009.

Between 2002 and 2012, about a quarter of Canada’s manufacturing businesses closed shop. With so much scrapped machinery and equipment, it will be some time before capacity recovers.

Uncontrolled resource extraction has been a major driver of the profound restructuring in manufacturing. High oil prices fuelled high profits in petroleum and related industries, sparking a sharp increase in foreign direct investment and speculative inflows. This led to a rising exchange rate and a dramatically overvalued dollar relative to the fair value of the currency. While the US dollar was falling against world currencies at the same time, the Bank of Canada attributed about half of the loonie’s overvaluation to oil prices and currency speculation.

The dramatic expansion of oil and gas extraction, coinciding with the decline of central Canadian manufacturing, had a profound impact on the economy. By the mid-1990s, it become less diversified, resilient and productive. In the early 2000s, the share of raw and semi-processed materials in Canadian exports rose, and economic activity shifted away from tradeable sectors.

As these imbalances unwind, the importance of a revitalized manufacturing sector is clear. High productivity levels and relative high rates of its growth are critical to our economy and standard of living, and to create well-paid, high-quality employment. Manufactured products are vital for a successful trade strategy, avoiding ongoing balance of payments problems, and strong growth in external demand is an important driver of productivity growth.

Invest in R&D
Manufacturing accounts for a higher share of GDP allocated to R&D, which strengthens innovation through the economy via links to services and other industries. Investing in the sector will be necessary if we want to lift business spending on R&D (0.88% of GDP in 2012), which is down from 2002 levels, and well below the OECD average of 1.63%.

Canada also needs a new approach to resource extraction. Building on our resources fosters wider, long-term economic opportunities in manufacturing and other industries.

This would require deliberate steps to promote refining, processing and the secondary manufacturing of raw materials in Canada. Measures are also needed to ensure the machinery, equipment and services – as inputs to the resource industry – contain a growing level of Canadian content.

Canada’s trade deficit in industrial machinery and equipment doubled between 2001 and 2012. A sectoral strategy to manufacture industrial machinery could aim at reducing carbon emissions in resource extraction while seeking new domestic and international markets connected to green economies over the longer-term.

A sovereign wealth fund to capture a greater share of petroleum revenues would also help stabilize the economy, finance investment in manufacturing and cushion against future swings in oil prices.

Something to think about before the next “gold rush” in the oil and gas sector gets underway.

This article appears in the March 2015 issue of PLANT.